“Cov-Lite” Loans, Junk by Any Other Name, Dominate US Leverage Debt

Fast and easy. This is how debt flows at the top of a cycle, at peak bubble inflation.

Cov-lite loans are an excellent example of cheap, uncollateralized, highly risky debt. And their issuance, as an overall percentage of US leveraged loans, is at all-time highs.

According to a report last week from the International Monetary Fund (IMF), the global debt pile is bigger than ever. The sum of private and public debt worldwide is $164trn, or 225% of GDP. That’s 12% of GDP more than in the late 2000s.

Even more concerning than overall debt levels, however, are the “late-stage, credit-cycle dynamics” and “investor excesses” that are worryingly reminiscent of the peak of the last bubble, according to the IMF. Risky lending has returned with a vengeance in the past few years.

Leveraged loans in the US have doubled since the pre-crisis peak. Within this category, notoriously lenient “cov-lite” loans, with little covenant protection, comprised 75% of new loan issuance in 2017. Equity-market investors have been borrowing to buy stocks in rapidly increasing numbers: margin debt has hit record levels.

China won’t come to the rescue either. It embarked on a government-induced lending spree when exports collapsed in 2009, leaving it with the biggest credit bubble in history. The sum of its household, government and corporate borrowings has ballooned from under 150% of GDP to more than 250% in a decade.

The world is not ready for a sharp rise in borrowing costs in the biggest economy, but thanks to the Trump government’s stimulus, which is being injected “at the top of the cycle”, investors are beginning to fret about overheating and a jump in inflation.